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Can Gulf ETFs Keep Glowing?

Rising interest rates in the US, strengthening US dollar and improving domestic economy have hurt the near-term outlook for emerging markets. As a result, many emerging markets ETFs have tumbled in the last few weeks.

Surprisingly while the carnage in emerging markets has grabbed the headlines, not many investors know that some of the smaller emerging markets/frontier markets have been rather immune to the global sell-off. (Read: Winning ETF Strategies for the Second Half)

Frontier markets’ low correlations with developed markets somewhat shields them from the developments in major markets. Among the stock markets that have stood out during the challenging times for emerging markets in general, Gulf markets are definitely worth a mention. Their outperformance was in part due to a recent upgrade by MSCI.

During its latest classification review MSCI promoted UAE and Qatar to emerging market status from frontier market. The upgrade is expected to result in massive increase in capital flows to the region. (Read: Are Housing ETFs back on track?)

The move was not unexpected as these countries’ upgrade was being considered by the MSCI for the past many years. However the funds tracking MSCI index will likely begin investing in these countries only after May 2014.

Gulf countries are well known for these oil reserves leading to high GDP per capita and many of these countries have spent a lot of resources in building up institutions and introduced business friendly reforms. Due to expansionary fiscal policies and low interest rates, economic activity has remained steady in recent years.

Per IMF, growth rates in these countries will remain strong next year as well-- Kuwait (3.1%), Qatar (5.0%) and UAE (3.6%). UAE and Qatar peg their currencies to the US dollar and while Kuwait pegs its currency to a basket of currencies, the basket is believed to be heavily weighted towards the greenback. As a result these currencies have remained stable in the last few months, while many emerging markets currencies have tumbled against the US dollar.

In recent decades, these countries have used their oil wealth to build up reserves and their sovereign wealth funds hold about $1.5 trillion of external assets. Thanks to high regulatory oversight, the financial sector in these countries is very well capitalized. Private sector investment has been picking up which has partly offset the impact of weak oil prices. At the same time, a lot needs to be done in terms of opening up the markers to foreign ownership.

GULF tracks the WisdomTree Middle East Dividend Index, which measures the performance of companies in the Middle East region that pay regular cash dividends. Components’ weightings in the index are based on cash dividends paid by them in the prior annual cycle.

Dividend yield is very attractive at 3.86% currently. UAE (37.9%), Qatar (28.4%) and Kuwait (16.2%) account for 82.5% of asset base. The fund is slightly less concentrated in financials (49.6%), while Telecom (29.6%) and Industrials (16.2%) round out the top three.

GULF has returned 19.9% year-to-date and 40.9% over the past three years. The fund charges its investors 0.88% for annual expenses.

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